3, 5 or 10 years: how to decide on the right mortgage term

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Consider the pros and cons of different loan terms before choosing one

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Finding the lowest mortgage rate isn’t enough to tailor your mortgage to your budget and lifestyle.

The length of your mortgage should be a major concern when comparing lenders and loan products. The length of your mortgage will influence the flexibility you have as a homeowner and the predictability you have in knowing what your mortgage will cost you each month.

Three common loan terms in Canada are three, five, and 10 years – and choosing a term is one of the most important mortgage decisions you’ll make when entering Canada’s hot housing market.

3 year term

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Mortgage terms in Canada can vary from six months to 10 years. While three-year terms aren’t the most common of the bunch, they’re chosen by 20% of borrowers, according to the Canadian Association of Accredited Mortgage Professionals. And, they can offer a range of benefits.

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One of the most attractive aspects of a shorter loan term, such as a three-year term, is flexibility.

While homeowners often have intoxicating fantasies of finding their forever home on the first try, 7 in 10 repeat buyers move out sooner than they think, according to a survey by TD Canada Trust.

“The biggest benefit of a three-year period for the consumer is a shorter time frame in case they don’t know what their long-term strategy is with their mortgage going forward,” says Frances Hinojosa, Managing Partner by Tribe Financial. “It gives them a safety net knowing, at a really good interest rate, that they could take a break from [the three-year] point and reconsider their options. “

Three-year loans usually come with lower interest rates – which sounds great at first, but not so much once you wonder why.

Lenders offer lower rates on short term mortgages in order to balance your risk of facing a higher rate in just three years, at the end of the term.

Three-year fixed mortgage rates have historically been lower than their five- and ten-year counterparts, but from June 2020 to early March of this year, they were on average higher than five-year fixed rates. Make comparisons to find a lender with the best three-year mortgage rates today.

5 year term

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The five-year fixed rate mortgage is the ancestor of mortgages in Canada. This is the product that is pushed the most by the biggest banks and, because of it, it is the loan term that most borrowers gravitate towards.

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You will generally pay a higher interest rate on a five-year term than on a three-year term. It is the compromise of having two more years of stability. The predictability of knowing what your mortgage payment will be for the next 60 months can be quite appealing to homeowners on a budget and may be worth sacrificing a few basis points on your mortgage rate. One basis point is one hundredth of 1 percent.

“It’s a good way to maintain long-term rates,” Hinojosa says.

Your lender will also look for stability when approving your loan. A lender cash – pun intended – by collecting five years of interest from you, so if you break your agreement and pay off your mortgage early, expect to feel pain.

Weigh the risks before signing

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This is one of the biggest risks of accepting a five-year mortgage: if your plans change unexpectedly and you have to sell your house, transfer your mortgage, or break your mortgage contract, you may be forced to pay. a colossal prepayment penalty.

Your penalty will be either three months of interest on the amount you still owe, or what’s called the Interest Rate Differential (IRD), a fairly complex calculation that your lender will base on several interest rates. . Let’s just say that the IRD is usually well over three months’ interest – in the thousands – and lenders almost always ask for the IRD amount.

Homeowner who recently broke a five-year fixed rate mortgage with CIBC had to repay $ 47,000 in prepayment fees. Hinojosa has already encountered a prepayment charge of $ 280,000. This mortgage was in the millions, but the lesson is the same for any loan amount.

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“Know the features, know the cost,” says Hinojosa. “And make sure it’s something that, if you commit for five years at a fixed rate, you stay committed.”

The five-year fixed market is one of the most competitive in the Canadian mortgage market. In early March, several mortgage rate comparison sites reported that the lowest rate for a five-year fixed-rate mortgage had risen by a quarter of 1 percentage point (0.25) to settle. to 1.64%, the first such increase since January of last year.

Since major Canadian banks recently raised their mortgage rates, you might want to move quickly to get an advantageous rate if a five year term is the term you are looking for.

10 year term

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A choice for about 5% of Canadian homeowners, the 10-year mortgage term will not win any popularity contests. But when weighing your options, it’s worth taking a few minutes to make sure you’re getting their full weight.

A 10-year mortgage is a relatively safe choice if you’re unlikely to move or sell for an extended period. The peace of mind that comes from knowing your mortgage payment won’t go up for a full decade is tremendous, and what five- and three-year mortgage holders don’t get. This is why these longer term loans will cost you more in interest.

But 10 years, even for homeowners who have no intention of disrupting their current, comfortable lifestyle, is a long time to expect.

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“Nobody has a crystal ball,” says Hinojosa. “Life is coming, and you never know what’s coming.”

Breaking a 10-year fixed rate mortgage after the first five years will cost you three months of interest, but breaking within the first five could result in a massive prepayment penalty that will eclipse those associated with the five-year terms. years.

“The times I’ve seen clients take 10-year terms, when it made sense, it was investment properties where there was a 10-year option, because then you’re going to have a stability of the cost relative to incoming income for this long-term holding. »Says Hinojosa.

Next steps in your mortgage journey

Once you determine the mortgage term that best meets your financial needs, you will be better prepared to compare what lenders are offering, not only in terms of mortgage rates, but also in terms of additional fees and conditions that will determine the ultimate cost of your mortgage.

“Look for the solutions, not the cost,” advises Hinojosa, “because that’s where you’re going to save the most in the long run.”

When you’ve decided which type of mortgage is best for you, compare the rates and loan offers of several lenders to find the best loan and the lowest mortgage rate.

And the better your credit rating, the better your rate. Anything over 760 is excellent. Today it is easy to check your credit score for free online.

This article was created by Wise Publishing, Inc., which provides clear, reliable information people can use to take control of their finances. Millions of readers across North America have come to rely on the Toronto-based company to help them save money, find the best bank accounts, get the best mortgage rates, and navigate many other financial matters.

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